Lease Options – Please Help!

Over the past month I’ve received a number of questions from both clients and agents regarding Lease Options. I’ve summarized the basics around lease option agreements in this post. I recommend that you speak directly with an attorney or your principal broker about the specifics of helping your client fill out the forms. Here are some of the highlights that I train my team on:

OREF Definition: Simply stated, an option is nothing more than an agreement by an owner to sell a property to a buyer for a fixed purchase price. The offer remains locked in at the fixed price for a certain period of time, during which the buyer can “opt” to buy the property for the agreed price – or walk away with no further obligation. During the option period the seller cannot revoke the offer, change the price or any of the agreed-upon terms, or sell the property to someone else. Obviously, there is value to a potential buyer to have this ability to unilaterally buy or not buy, and for this right the parties must agree upon the consideration – i.e., the price for the option, which is normally paid up front. An Option Agreement differs from a Sale Agreement in several ways, but one of the main differences is that the option consideration paid by the potential buyer is nonrefundable (assuming the seller doesn’t default under the Option Agreement), regardless of whether the buyer decides to purchase or walk away. If the option is not exercised by the buyer within the agreed-upon time period, then the right of purchase for the fixed price expires and the option consideration is retained by the seller.

Four Components: There are four major components to a lease option transaction. OREF provides agents with forms for three of the components and I recommend that you use these forms and have them reviewed by your client’s attorney. A standard lease agreement can be used and may be purchased from one of the local housing association offices.

1. Lease Agreement: This is the agreement between buyer and seller for renting the home during the option period. It will cover terms and conditions related to leasing the property and will be governed by the Landlord Tenant Law of Oregon.
2. Option Agreement: This is the agreement that spells out the terms and conditions of the buyer paying for the option to purchase the property in the future. It will summarize the terms of the lease agreement and layout the obligations of both parties as related to exercising the option at a future date.
3. Sales Agreement: This is the standard OREF real estate sale agreement that we all use every day in our business. It will spell out the conditions and terms of the future sale that will occur when the option is exercised.
   
4. Memorandum of Option Agreement: this memorandum should be recorded to protect both the buyer and seller. It should be reviewed by an attorney prior to recording and must be executed in the presence of a notary. It will put the world on notice of the option agreement between the buyer and seller.
   

Pros to a Lease Option Agreement:

1. Buyers are able to “experience” the neighborhood, schools, and amenities of the area before they actually buy in the area.
2. If there are credit issues, the lease period allows time for a buyer to repair their credit and save money for the down payment on the home.
3. A long term lease option may allow for a seller to “ride out” a declining market and be able to sell their home at the price they need.
4. Buyers may be able to negotiate with the seller to have a portion of their lease payment go towards the future down payment on the property.
5. Sellers may be able to charge above market rents to a buyer providing the seller with positive cash flow each month.

Cons to a Lease Option Agreement:

1. The seller’s underlying loans may have restrictions about leasing or renting the property. If this is the case both parties must be aware of the risk associated with a due on sale clause where the lender may call the underlying loan due upon receiving notice the borrower is no longer in possession of the property.
2. If the seller fails to make the mortgage payment the home may be foreclosed on ending the buyer’s hopes of owning the home.
3. Declining home prices may require the buyer and the seller to renegotiate the final price of the home when the option is exercised. The buyer may risk the money they have invested if they cannot come to terms with the seller on a new price. The seller may lose a buyer that decides not to exercise the option because of the declining prices.
4. As with any rental the occupant may not care for the home at the same level the owner does creating a situation where the owner must do repairs at the end of the option period if the buyer chooses not to exercise the option.
5. Rising interest rates may keep a buyer from being approved for a loan at the end of the lease term – even though he is currently approved to buy at the current price.

How Do You Get Paid?
Remember in Oregon you cannot be paid in advance for services rendered. You can however be paid for the cash flows that you create for your client. There are three different cash flows created with a lease option agreement. If you choose to be paid in one of the non-standard ways it will most likely not add up to the total commission you are due at the time of the sale. You are able to take these payments prior to the sale of the property as a credit against your commissions owed at the closing of the sale.

1. Gross Rents: The buyer and seller will sign a lease agreement for a specific length of time. You can be paid up front on the gross rents to be collected from this lease agreement. For example, the buyer and seller sign a 24 month lease at $1000 a month; you can be paid a percentage of the gross lease payments ($24,000). Typical rates for this sort of commission range from 4% to 6% depending on your market area.
2. Option Fee: The buyer will pay the seller an option payment for purchasing the right to have the option to buy the property. The option payment ranges from 1% to 2% of the agreed upon sales price but may be higher depending on your market. You can be paid a commission on the total option payment made to the seller. Commission rates typically range from 5% to 10% of this option fee amount.
3. Sale Proceeds: If the buyer exercises the option to purchase the home at the end of the lease (or prior), you may earn your normal commission on the sale of a home. This is how most agents agree to be paid and the commission rates that apply are those outlined in the Multiple Listing Data Sheet under the Buyer Agent Commission section (BAC).

There is much more to consider before consulting your clients on lease options, however, I believe its appropriate to just provide the above summary and allow you to work directly with your principal broker on specifics.

Question: Have you used a lease option this year? What was your experience and what did you learn about the process?

Make it a great day!

Coach Dan

www.PurposeDrivenBroker.com

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